While most traders focus on bullish patterns, understanding bearish formations can be equally profitable. The inverse cup and handle pattern is the mirror image of the popular bullish cup and handle, signaling potential downside moves. This guide will teach you how to identify and trade this powerful bearish pattern.
What is an Inverse Cup and Handle Pattern?
An inverse cup and handle, also called an inverted cup and handle, is a bearish continuation pattern that forms during a downtrend. It looks like an upside-down tea cup and signals that sellers are likely to push prices lower after a period of consolidation.
Key insight: The inverse cup and handle is a bearish continuation pattern. It forms during downtrends and suggests the stock will continue falling after the pattern completes. This makes it valuable for short sellers and put option traders.
Understanding the Pattern Structure
The inverse cup and handle has the same components as its bullish counterpart, just flipped upside down:
The Inverted Cup
Instead of a rounded bottom, this pattern features a rounded top. Key characteristics include:
- Prior downtrend: The stock should already be in a downtrend before the pattern forms
- Dome-shaped top: Price rallies, rounds over, and declines back to the starting level
- Arc formation: The top should be smooth and rounded, not a sharp peak
- Equal lows: Both sides of the inverted cup should reach similar price levels
- Depth: The rally typically retraces 12% to 33% of the prior decline
The Inverted Handle
After the inverted cup completes, a short upward drift forms the handle:
- Upward drift: Price bounces slightly or moves sideways
- Shallow bounce: Should not rally more than 12% to 15% of the inverted cup depth
- Decreasing volume: Volume should contract during handle formation
- Duration: Typically lasts 1 to 4 weeks
Pattern Formation Example
Stock ABC has been falling and currently trades at $100. Over the next 8 weeks:
- Price rallies from $100 to $115 (left side of inverted cup)
- Price rounds over at $115 and begins declining
- Price falls back to $100 (right side of inverted cup)
- Price bounces slightly to $103 over 2 weeks (inverted handle)
- Price breaks below $100 on increased volume - this is your short signal
How to Trade the Inverse Cup and Handle
Trading bearish patterns requires a different mindset. Here is how to approach the inverse cup and handle:
Entry Strategies
You have several options for entering a short position:
- Breakdown entry: Short when price breaks below the neckline (bottom of the cup) on high volume
- Handle entry: Short at the top of the handle with a tight stop loss
- Retest entry: Wait for price to break down, then retest the neckline as resistance
Stop Loss Placement
Protect your position with proper stop placement:
- Conservative: Place stop above the top of the inverted handle
- Aggressive: Place stop just above the breakdown level
- Keep risk under 7-8% of your entry price
Price Target Calculation
Calculate your profit target using the measured move method:
- Measure the height of the inverted cup (from neckline to dome top)
- Subtract this distance from the breakdown point
- This gives you your minimum price target
Trade Setup Example
Using our ABC example:
- Neckline (breakdown level): $100
- Inverted cup top: $115
- Pattern height: $15
- Price target: $100 - $15 = $85
- Stop loss: $105 (above handle high)
- Risk: $5 per share
- Reward: $15 per share (3:1 ratio)
Volume Confirmation
Volume analysis is crucial for validating the pattern:
- Inverted cup formation: Volume typically increases on rallies and decreases on declines
- Handle formation: Volume should contract significantly
- Breakdown: Volume should spike above average, confirming seller conviction
Trading Methods for Bearish Moves
You can profit from the inverse cup and handle in several ways:
Short Selling Stock
The most direct approach is to borrow and sell shares:
- Requires a margin account with short selling enabled
- Unlimited risk potential if the trade goes against you
- Must locate shares to borrow before shorting
Put Options
Buying put options offers defined risk:
- Maximum loss is limited to the premium paid
- Leverage allows for larger percentage gains
- Choose strikes at or slightly in-the-money for best results
Bear Put Spreads
A cost-effective options strategy:
- Buy a put option at a higher strike
- Sell a put option at a lower strike
- Reduces cost and defines both risk and reward
Common Mistakes to Avoid
Watch out for these errors when trading the inverse cup and handle:
- Shorting in uptrends: Only trade this pattern when the broader trend is bearish
- Ignoring volume: Breakdowns without volume often reverse quickly
- Wrong pattern shape: The top should be rounded, not a sharp spike
- Handle too deep: A handle that rallies too much may invalidate the pattern
- Fighting the trend: If the market is strongly bullish, bearish patterns often fail
Comparing Bullish vs Bearish Cup and Handle
Understanding both patterns helps you trade in any market condition:
- Cup and handle: Forms in uptrends, signals continuation higher
- Inverse cup and handle: Forms in downtrends, signals continuation lower
- Both require volume confirmation on breakout or breakdown
- Both use the same measured move calculation for targets
Best Market Conditions
The inverse cup and handle works best when:
- The overall market is in a downtrend or correction
- The stock has deteriorating fundamentals
- Sector rotation is moving away from the stock's industry
- There is negative news or earnings disappointment
Track All Your Trades
Pro Trader Dashboard tracks both long and short positions. Analyze your performance on bearish patterns, see your success rate, and identify areas for improvement.
Summary
The inverse cup and handle is a reliable bearish pattern that can generate significant profits when traded correctly. Remember to wait for proper pattern formation, confirm breakdowns with volume, and always manage your risk. Whether you short stocks or use options, this pattern can be a valuable addition to your trading arsenal.
Want to learn the bullish version? Read our guide on the cup and handle pattern. Also explore the rounding top pattern for another bearish formation.